BILL ANALYSIS                                                                                                                                                                                                    



                                                                  AB 1837
                                                                  Page  1

          ASSEMBLY THIRD READING
          AB 1837 (Gaines) 
          As Amended  May 20, 2010
          Majority vote 

           INSURANCE           10-2                                        
           
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          |Ayes:|Solorio, Blakeslee,       |     |                          |
          |     |Anderson, Caballero,      |     |                          |
          |     |Carter, Hagman, Hayashi,  |     |                          |
          |     |Niello, Salas, Torres     |     |                          |
          |     |                          |     |                          |
          |-----+--------------------------+-----+--------------------------|
          |Nays:|Charles Calderon, Feuer   |     |                          |
          |     |                          |     |                          |
           ----------------------------------------------------------------- 
           SUMMARY  :   Authorizes a nonadmitted (unlicensed) insurer that is  
          affiliated with a domestic admitted insurer to receive services  
          performed in California by the domestic admitted affiliate.   
          Specifically,  this bill  :  

          1)Authorizes a nonadmitted insurer that is affiliated with a  
            California domestic insurer to have common directors, provided  
            that the directors do not perform management functions for the  
            nonadmitted affiliate, and provided that the common directors  
            do not constitute a majority of the nonadmitted affiliate's  
            board. 

          2)Authorizes a California domiciled insurer to provide the  
            following administrative services to its nonadmitted  
            affiliate:

             a)   Computer operations, as specified, that are unrelated to  
               the underwriting process;

             b)   Clerical and administrative staffing support, provided  
               that the staff providing these services to not have contact  
               or interaction with policyholders of the nonadmitted  
               affiliate;

             c)   Human resources, provided that hiring and firing  
               decisions, employee discipline, and compensation decisions  
               are handled directly by the nonadmitted affiliate;









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             d)   Claims adjusting, as described in a specified Insurance  
               Code section, provided that the notices, decisions, and  
               payments are made directly by the nonadmitted insurer; and,

             e)   Investing services, provided that decisions on  
               investment goals, risk assumptions, diversification and  
               liquidity needs are made directly by the nonadmitted  
               affiliate.

          3)Specifies that nothing in the above provisions permits the  
            nonadmitted insurer to conduct activity that constitutes the  
            "transaction" of insurance, or a violation of specified  
            sections of the Insurance Code.

           EXISTING LAW  :

          1)Requires insurers that "transact" insurance in California to  
            be "admitted" to transact in the state.  "Admitted" is the  
            Insurance Code terminology for being licensed to transact  
            insurance in this state.

          2)Provides that "transact" as it applies to insurance includes  
            solicitation, negotiations preliminary to the execution of an  
            insurance contract, execution of the contract, and transaction  
            of matters subsequent to the execution of, and arising out of,  
            the insurance contract.

          3)Authorizes "nonadmitted" insurers to sell insurance to  
            Californians on a limited basis, through specially licensed  
            "surplus lines brokers."  

          4)Provides broadly that nonadmitted insurers may sell insurance  
            to Californians when the insurance is needed by the  
            policyholder, but generally not available from admitted  
            insurers.

          5)Requires that, before selling insurance on a nonadmitted basis  
            in California, the nonadmitted insurer must apply to be placed  
            on the list of eligible surplus lines insurers (LESLI list),  
            and the Insurance Commissioner (IC) must approve the  
            application based on statutory criteria before placing the  
            nonadmitted insurer on the list.

          6)Prohibits in virtually all circumstances a nonadmitted insurer  
            from selling insurance in California except though a surplus  








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            lines broker, who reaches out and places the California  
            insurance with the nonadmitted insurer outside of the state.   
            In this sense, the nonadmitted insurer is not "transacting"  
            insurance in California.

          7)Places a series of duties on the surplus lines broker to  
            ensure that these requirements are met.

          8)Recognizes the role of the Surplus Lines Association (SLA), a  
            nongovernmental entity, as an administrative agent of the IC  
            for carrying out certain functions, including a role in tax  
            collection and a role in pre-screening applicants for  
            placement on the LESLI list.

          9)Establishes the California Insurance Guarantee Association  
            (CIGA) as the guarantor for the payment of covered claims in  
            the event an admitted insurer becomes insolvent.  There is no  
            comparable entity for nonadmitted insurers.

          10)Defines a "domestic" insurer as one that is organized under  
            the laws of California.

          11)Defines "nonadmitted" as an entity that is not entitled to  
            transact the insurance business in California.

           FISCAL EFFECT  :   Undetermined.

           COMMENTS  :   

          1)According to the author and the sponsor, the Pacific  
            Association of Domestic Insurance Companies (PADIC),  
            California domestic insurers face a competitive disadvantage  
            in comparison to non-domestic admitted insurers with respect  
            to the operations of affiliated nonadmitted insurers.   
            Specifically, the author and PADIC argue that a non-domestic  
            admitted insurer can share a range of services and cost-saving  
            activities with a nonadmitted affiliate that is selling  
            insurance in California, but a domestic insurer cannot provide  
            those same services to its nonadmitted affiliate without  
            violating the laws that bar a nonadmitted insurer from  
            transacting insurance in the state.  The bill is intended to  
            level this playing field among nonadmitted insurers.

          2)The general rule in California, as in every state, is that an  
            insurance company must be licensed (admitted) in order to do  








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            business in the state.  There are sound reasons for this rule,  
            notably the ability of the IC to regulate the solvency of  
            these companies to ensure they can keep their promises to pay  
            future benefits to Californians, and to ensure that the  
            insurers treat policyholders and claimants in a fair and  
            reasonable manner.  In addition, in California admitted  
            property-casualty insurers are subject to a rate regulation  
            law that was enacted by the voters (Proposition 103 of 1988).

          However, despite these sound reasons to require all insurers to  
            be admitted, the law recognizes that there are reasons to  
            allow the sale of insurance by nonadmitted insurers.  If there  
            is an insurance need by a California resident, and that need  
            is not being filled by admitted insurers, it is logical that  
            the law allow that need to be filled.  Thus, for unusual  
            risks, or for very large risks, the nonadmitted market plays a  
            crucial role in providing commercial insurance in California.   
            There is a small amount of personal homeowners insurance sold  
            by nonadmitted insurers in California, but virtually all  
            nonadmitted insurance is in the commercial lines.

          3)In the 1980s and early 1990s, the surplus lines market was far  
            less regulated than it is today.  As a result, extremely  
            poorly capitalized insurers would start writing business to  
            unsuspecting consumers, and all too frequently these insurers  
            would default on their obligations.  The automobile insurance  
            crisis was at the point where hundreds of thousands of  
            Californians were purchasing basic automobile insurance from  
            nonadmitted insurers.  At that time, the law did not require  
            nonadmitted insurers to apply for and be placed on an  
            eligibility list.  Indeed, there were not even financial  
            filing requirements.  The DOI attempted to deal with this  
            problem by adopting a regulation that mandated a  
            contemporaneous financial filing at the time when a  
            nonadmitted insurer first sold a policy to a Californian.   
            However, even this approach proved inadequate, as the courts  
            made it extremely difficult for DOI to shut down financially  
            unsound nonadmitted insurers, because these insurers had  
            established a "property right" in the business that they were  
            conducting.  The Legislature responded to this problem by  
            enacting laws that in most circumstances prohibit private  
            passenger automobile insurance to be sold by nonadmitted  
            insurers, and by creating the LESLI list to ensure no  
            nonadmitted insurer could establish the foothold "property  
            interest" unless the IC had affirmatively approved the  








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            nonadmitted insurer's status as financially sound.  These  
            changes have improved the market, but also highlight the fact  
            that selling insurance on a nonadmitted basis is a privilege  
            granted by the state, to be authorized only where there is a  
            clear need to fill a void.  Without a need to fill a void,  
            insurance should be sold by licensed companies only.

          4)PADIC writes in support that the bill recognizes that the  
            nonadmitted regulatory process is fundamentally unfair to  
            small and medium sized domestic insurers due to the ability of  
            nonadmitted affiliates of nondomestic insurers to save costs  
            more effectively with respect to competing for California  
            business.  PADIC also makes the case that California should be  
            encouraging insurers to locate their primary offices within  
            the state, and that this bill will enhance the ability of  
            insurers that do locate here to better compete.

          5)Proponents suggest that nonadmitted affiliates of a domestic  
            insurer are at a competitive disadvantage with nonadmitted  
            affiliates of nondomestic insurers.  In a certain sense, the  
            observation is valid.  However, it misses the mark at two  
            levels.  First, a nonadmitted affiliate of a United States  
            based insurer will always have one state where there is this  
            appearance of disadvantage - the state where its affiliate is  
            domesticated.  Thus, just as a nonadmitted affiliate of a  
            California domestic faces issues when selling insurance in  
            California, a nonadmitted affiliate of a Nevada domestic faces  
            issues when selling insurance in Nevada, and the  
            California-affiliated nonadmitted has a competitive advantage  
            over that insurer in Nevada.  Of course, the size of the  
            California market magnifies the disadvantage for a California  
            domestic.  Second, the notion of level playing field  
            competition in the context of nonadmitted insurance in the  
            absence of any showing of a market void ignores the fact that,  
            under California law, if a company wants to compete and  
            exercise its rights under the law, it should become admitted.

          6)A nonadmitted insurer that is selling insurance in California  
            should be a real company, with its own assets, offices,  
            management and staff.  The current version of the bill is much  
            narrower than previous versions.  The DOI has been concerned  
            with blurring the lines between admitted and nonadmitted  
            insurers, and the recent amendments have clarified the limited  
            range of services that the domestic insurer may provide  
            without crossing the "transaction" threshold.  As DOI  








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            testified in Committee, earlier versions of the bill were  
            breaking new ground that could render the distinction between  
            admitted and nonadmitted insurers virtually nonexistent, and  
            the recent amendments provide the limits and detail to avoid  
            that problem.


           Analysis Prepared by  :    Mark Rakich / INS. / (916) 319-2086


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